How to develop competitive strategy

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The Wamda Research Lab’s new report on investment activity in
the MENA region highlights several alarming data points. The
finding that investors don’t believe that entrepreneurs are capable
enough at defining and directing strategy for their companies is
the first among them. More than half of investors – 56% –
identified “strategic planning and decision making” as the biggest
weakness among people who start companies in the region. The
second-most cited weakness, insufficient financial literacy, also
goes to a business-owner’s ability to learn a market and maneuver
into an advantageous position within it.

This article aims to provide a brief overview of one of the most
popular models for thinking about strategy – the Five Forces model.
Readers who are interested in learning more should watch this lecture by
Harvard Business School Professor Michael Porter – and they may
consider reading
his authoritative book, Competitive Strategy.

What is competitive strategy?

Many people have an intuitive sense of what strategy is. They
may think of it as a way of matching goals and actions, of steering
an enterprise, or of matching competencies to opportunities.
According to Porter, “strategy is the big picture of how an
organization is going to win in its environment, whatever that
is.”

Porter’s big contribution to the study of strategy came through
the development of a five-forces framework. It
allows practitioners to understand the industry within which they
compete and their strategic position within the industry. For
example, the airline industry is notoriously difficult to achieve a
profit within; that’s borne out by an industry-level analysis. Yet
individual carriers are capable of producing better-than-average
returns through focusing on positioning within the industry.
Ryanair and Emirates are both airline companies that achieve
profitability, but they do so through vastly different strategic
choices and positioning within their industry.

Here it’s worth clarifying the difference between “operational
effectiveness” and “competitive strategy.” Operational
effectiveness is about doing things well or more efficiently –
using Excel instead of pen and paper, building macros that run
models instead of running them manually, streamlining processes,
and so forth. Strategy is about steering an operationally effective
ship to the richest fishing waters available to it, given its
capabilities.

To extend the analogy, a highly efficient whaling ship will fail
to catch whales if its captain steers it into the Mediterranean – a
strategic failure. And a whaling ship whose harpoons are dull,
whose crew is disorganized, and whose sonar is outdated will fail
to catch whales, even if it does sail into the Pacific. Both
operational effectiveness and strategy are necessary for success.
But they’re different.

The Five Forces Framework

Before Competitive Strategy was published in the 1980s,
researchers, economists, and practitioners had a fairly limited
view of competition. Many regarded it (and continue to regard it)
as a zero-sum game in which companies work to seize market-share
from their competitors. That struggle ultimately leads to
undesirable profit erosion.

Porter encourages executives to think instead about a range of
forces that contribute to an enterprise’s entire value chain and
value proposition. Through value chain segmentation companies can
identify their best opportunity at “competing to be unique,” a
characteristic which can drive profitability.

The five forces are:

1) Supplier bargaining power

Any company that delivers something to customers has suppliers.
A furniture maker may be supplied with lumber through a mill or
distributor, workers who make the furniture, electricity, and so
on. A video game company relies on talent, which is a necessary
input for the industry (as well as an expensive one).

Invariably, suppliers have bargaining power. One part of a
company’s margins is driven by its relationship to suppliers.

2) Buyer bargaining power

Similarly, buyers in a market place may affect the price of
goods through a range of activities that enhance their negotiating
power. They may possess better information or the goods themselves
are abundant. Significantly, buyers may have substantial or limited
bargaining power on price. Buyers in luxury markets have limited
bargaining power while those in commodity markets have more.

3) Threat of new entrants

Are there substantial barriers to entry in one’s industry? For
airlines, the answer is yes. Airplanes are expensive. Licensing is
a challenge to attain and in many markets domestic carriers are
protected through legislation. But the barriers to entry alone are
insufficient for driving profitability.

4) Threat of substitutes

One example that often comes up here is the iPod. Before its
creation, CDs were ubiquitous. Today, people rarely use CDs and a
whole new industry has been created.

5) Industry rivalry

This one is self-explanatory. Do industry participants compete
intensely on similar products? What does the existence of Coca Cola
do to PepsiCo’s ability to generate profits through soft drink
sales?

How to compete

Understanding one’s industry is a research-intensive
undertaking. It’s something that entire consulting practices are
built around. But once the analysis has been completed, developing
a viable, defensible strategy for maintaining and growing
profitability becomes paramount.

Each of the inputs into the five forces model provides an
opportunity for a company to assess the underlying relationships
that impact margins. And invariably different companies with
different strengths can deliver on those opportunities in different
ways. Walmart has enormous bargaining power with suppliers, a fact
that ultimately allows it to compete on price with
competitors, for example.

Porter encourages managers and executives to avoid competing on
the same dimensions as competitors, a strategy that will ultimately
erode margins. Instead, he suggests that companies compete to be
“unique” – which is the opposite of being everything to every
customer in an industry. This strategy can be described as
competing on differentiation.

The executive team at Emirates actively chose not to cater to
price-sensitive travelers – a strategy supported by their access to
resources and internal competencies. Managers at Ryanair actively
chose to ignore the entire luxury traveler segment of the market,
which was supported by their resource limitations and geographic
location when the strategy was articulated. Those choices have
allowed each company to thrive in an otherwise crowded and
competitive industry.